14th letter to friends of Brunei [Portfolio Management (Part 1)]

When you have 2 or more assets in an investment plan, this is known as a "portfolio", and the calculation of its returns and risks has some variations as compared to single asset.

1. Calculating portfolio return

The return on a portfolio of assets is simply the weighted average return.

For example: Mary has a portfolio of 4 common stocks with the following market values and returns.

Stock [Market Value] (Stock Return)

A [$10k] (10 %)

B [$ 20k] (14 %)

C [$ 30k] (16 %)

D [$ 40k] (15 %)

Total $100k

Mary's portfolio return is:

[10k/100k](10%) + [20k/100k](14%) + [30k/100k](16%) + [40k/100k](15%)

= [0.1](10%) + [0.2](14%) + [0.3](16%) + [0.4](15%) = 14.6%

Let's try another example: The assets X,Y,Z have the following return statistics:

Assets (Returns)

X (18% )

Y (22%)

Z (26%)

What's the expected return of a portftolio containing 25% of X, 50% of Y, and 25% of Z?

a. 17.25%

b. 22.00%

c. 16.34%

d. 19.72%

You should have no problem in calculating portfolio returns after going through above two examples.

Cheers.

*Working for 2nd example:

Expected Return = (0.25)(18) + (0.5)(22) + (0.25)(26) = 4.5+11+6.5 = 22%

Therefore, the answer is b.